Manager Uncertainty and the Cross-Section of Stock Returns

Abstract

This paper evidences the explanatory power of managers’ uncertainty for cross-sectional stock returns. I introduce a novel measure of the degree of managers’ uncertain beliefs about future states: manager uncertainty (MU), defined as the count of the word “uncertainty” over the sum of the count of the word “uncertainty” and the count of the word “risk” in filings and conference calls. I find that managers’ level of uncertainty reveals valuation information about real options and thereby has significantly negative explanatory power for cross-sectional stock returns. Beyond existing market-based uncertainty measures, the manager uncertainty measure has incremental pricing power by capturing information frictions between managers’ reported uncertainty and investors’ perception of uncertainty. Moreover, a short-long portfolio sorted by manager uncertainty has a significantly positive premium and cannot be spanned by existing factor models. An application on COVID-19 uncertainty shows consistent results.

Keywords: Uncertainty, Manager, Heterogeneous Beliefs, Real Options, Cross-Sectional Stock Returns, Premium, asset pricing, Textual Analysis, Word Embedding, Machine Learning, COVID-19